Resolving the Asian currency crisis: IMF is not geared adequately to help

I refer to the letter "Attacking IMF and encouraging
resistance can worsen situation" by Professor
Linda Lim (ST, Jan 14), the interview with Professor
Jeffrey Sachs, "I'm in no government's pay" (The
Sunday Times, Jan 11) and the article "IMF: The
hand that knocked off the cradle" (Business Times,
Jan 16).

Prof Sachs may have overstated his case but Prof
Lim's analysis is not helpful either.

I do not agree that fair comment on the International
Monetary Fund is tantamount to "attacking IMF and
encouraging resistance".

There is surely a legitimate question about the
effectiveness of the IMF's rescue operations, if only
because regional currencies have continued their
downward slide with disastrous consequences.

It is true that there are strong sentiments in the
United States against further funding of the IMF,
but Prof Lim will surely agree that free and open
debate is the best way to ensure that the right
things are done.

Besides, the IMF also has its own track record and
is able to defend itself.

Allow me, however, to state my own position clearly.

I am not in favour of bashing the IMF, but I believe
that the resolution of the Asian currency crisis
requires resources and intervention beyond the
scope of the IMF.

The latter is not geared adequately for this kind
of crisis.

THE FACTS

[] Right up to July last year, nobody anticipated
the crisis or its extent.

[] The malaise affects several Asian countries

[] The root of the problem is unlike the typical
Latin American or African fiscal and monetary
excesses, with the exception of Chile in 1982
and 1985.

Its indebtedness was almost totally caused by
private sector overspending.

[] The proximate cause of the crisis is foreign
over-borrowing by banks, corporations and
individuals on a short-term basis.

According to Neil Behrmann's article, "Euro
banks admit to Asian lending spree (Business
Times, Jan 20) this amounts to US$ 241 billion
(S$ 421 billion) or 62 per cent of the Bank of
International Settlements' lending to Asia.

[] There were a number of structural defects or
"fault lines" that contributed to the crisis'
severity. There are:

1. The use of political rather than commercial
criteria in the allocation of loans, as in
Thailand and Indonesia.

2. Industrial policy used to finance massive
expansion of industrial capacity, resulting
in gluts, such as in South Korea.

3. Poor supervision of financial institutions.

4. Costly and unjustifiable bail-outs of
financial institutions, such as in Thailand.

5. A penchant for mega-projects -- albiet
financed and executed by the private sector
--- at above-market prices.

Needless to say, these came with
mega-commissions, without regard for
balance of payments implications.

THE ASIAN MIRACLE

How did the crisis happen? To understand
this we need to comprehend the Asian miracle.

One part of the miracle has to do with good
macroeconomic policies, high savings and
investment rates, plus a well-educated,
trained and hard-working labour force.

The other part has to do with the Plaza Accord
of September 1985, which devalued the US
dollar by some 50 per cent against the yen.

Because of the exchange rate pegging system
used by Asian countries, whereby, directly
the US dollar is dominant, Asian currencies
are effectively devalued, just as in the early
1980s they were over-valued along with the
dollar.

This triggered substantial capital inflows into
the Asian economies in four over-lapping
waves:

[] To cope with a strong yen, Japan relocated
many industries to East and South-east Asian
countries. This Japanese lead was followed
by European and American investors.

[] In the Asian countries, with the infusion of
direct investment in manufacturing, rents
rose and property appreciated, triggering
another wave of capital inflow, both to
develop property and to purchase it.

All these waves of foreign investment involved
substantial foreign borrowing on a short-term
basis, as currency risks were minimised by the
pegging of exchange rates.

THE ECONOMIC UNRAVELING

How did the boom unravel? There are three
dimensions.

[] The global scene:

Firstly, over the last decade, the US has been
trimming her Budget deficit which, in turn,
enabled monetary policies to be tighter.

At the same time, the American economy has
become more competitive through retooling,
and more.

Secondly, in recent years, the members of
the European Union have been tightening
fiscal and monetary policies, in order to
fulfill the Maastricht criteria, as a pre-condition
for membership of the common currency, the
Euro.

Thirdly, the early 1990s saw the emergence
on the global market of several new actors:
the former members of the Soviet Union,
Latin America, some African countries and
India.

THE REGIONAL SCENE

[] In early 1994, the Chinese yuan was devalued
35 per cent.

[] From 1995, the Japanese yen depreciated
30 per cent.

[] From 1990, the Japanese economy was
in depression, following its central bank's
unwise and sever deflation of the property
market.

[] From 1996 until late last year, the electronic
industry was in a downturn.

The impact of these regional factors on the
Asian economies was severe. Low-tech and
high-tech exports were hit badly.

THE NATIONAL SCENE

[] The property glut: As in the early 1980s, when
the US dollar was strong, the over-valuation
of regional currencies meant asset inflation
(there was a resource shift from the traded
goods sector to the non-traded sector).

Overbuilding resulted and the consequent
downturn affected share prices as well as
the health of financial institutions, which
were over-extended in property market
loans.

[] In recent years, the new World Bank-Asian
Development Bank orthodoxy or privatisation, and
hence reliance on the private sector for development
of infrastructure projects, led to extensive foreign
private borrowing for such purposes.

These projects generated heavy imports requiring
payment in foreign exchange, while the revenue
received was in domestic currency.

Subsequent repayments of interest and
amortisation contributed further to the current
account deficit.

Indonesia, for example, could borrow US dollars
at 6 to 7 per cent interest and earn 20 per cent
on rupiah deposits, netting a profit of 89 per
cent after the normal 5.6 per cent annual
depreciation of the rupiah.

The unraveling began with Thailand in July
last year and spread rapidly.

THE ROAD BACK

Prof Jeffrey Sachs has aptly used the analogy of
a run on the bank to explain the crisis. Asian
countries were essentially borrowing short to
invest in long-term assets.

Add the corruption, cronyism and mismanagement,
and the Paul Krugman hypothesis of over-investment
comes into the picture.

Unfortunately, unlike a domestic run on a bank, where
the central bank can step in with lender-of-the-last-
resort facilities, there is not international lender of
the last resort.

The IMF's functions are limited to supervising the
orderly conduct of international trade and finance,
and providing temporary financial to alleviate
balance of payments difficulties.

The IMF's remedies of fiscal and monetary
contradiction are more suited to problems arising
from government over-spending and printing of
money, and when foreign debt is largely sovereign.

The Asian crisis is radically different. Given the
short-term and private nature of the affected
countries' foreign debt, the sudden withdrawal of
funds by foreign lenders brought about a liquidity
crisis in the first instance, not a crisis of insolvency.